German ban on naked short-selling weighs on markets as euro clambers back off 4-year lows

German trading curbs weigh on markets

LONDON — World markets dropped sharply Wednesday after Germany’s new curbs on traders, a unilateral attempt to reduce volatility in financial markets, spooked investors.

The euro, meanwhile, recovered from four-year lows against the dollar — hit in the aftermath of the ban — as traders square off positions and experts suggest European central banks are considering intervening in the markets to slow the currency’s drop. The European Central Bank declined to comment.

By mid-afternoon, the euro was up 0.6 percent on the day at $1.2266, having earlier droped to $1.2146, its lowest level since April 2006.

In Britain, the FTSE 100 index of leading shares was down 131.72 points, or 2.5 percent, at 5,175.62 while Germany’s DAX plunged 159.63 points, or 2.6 percent, to 5,996.30. The CAC-40 in France was 83.45 points, or 2.3 percent, lower at 3,533.87.

In the U.S., the Dow Jones industrial average dropped 133.31 points, or 1.3 percent, at 10,377.64 an hour after the open, while the broader Standard & Poor’s 500 index fell 14.35 points, or 1.3 percent, to 1,106.45.

Once again, Europe’s debt crisis took center stage — this time the focus was on Germany, after its regulator’s surprise decision Tuesday to ban so-called naked short-selling of eurozone government bonds and shares in ten key German financial institutions until March 31.

In a typical short sale, a trader sells borrowed shares in hopes of buying them cheaper later and profiting on the difference. A “naked” short is when traders sell shares without borrowing them first.

The unexpected decision sent shock waves through the markets, especially as it was done unilaterally by the eurozone’s largest economy. The move came just as lawmakers begin a debate over authorizing Germany’s €123 billion contribution to an emergency support fund to protect the eurozone’s highly indebted countries from default and reassure financial markets.

The euro was the main casualty of the German move, dropping to a fresh four-year low of.

The currency is not out of the woods yet despite Wednesday’s rally, as investors worry that Germany’s ban is a symptom of just how bad things are in Europe

“While the euro relief rally is overdue, with the dollar clearly over bought, the euro has further to fall,” said Michael Woolfolk, senior currency strategist at Bank of New York Mellon, who reckons that it could be down at its launch rate of $1.18 soon.

There’s general unease in the markets about the reasoning behind Germany’s decision. Many analysts believe that central banks around the world will have to intervene to slow down the euro’s fall.

“A currency crisis will inevitably result in foreign exchange intervention as part of the EU ‘game-plan’ to eradicate financial market volatility and instability,” said Neil Mackinnon, global macro strategist at VTB Capital.

German Chancellor Angela Merkel defended the measure, telling lawmakers that Europe faces an “existential” test as it tries to shore up the euro and the ban on naked short-selling, she indicated, was part of a strategy to rein in speculators.

Merkel insisted that closer oversight of the financial world was needed to assert the “primacy of politics” in the debt crisis that has engulfed Greece, most notably, and sent the euro plunging on foreign exchange markets.

In the markets, the ban also brought back memories of a widely considered unsuccessful attempt by the U.S. and British authorities to prop up stock markets at the end of 2008 in the wake of the collapse of Lehman Brothers and the ensuing crisis that gripped the banking sector.

“If anything, the bans in 2008 exacerbated market declines and volatility, as investors took fright and bailed out of the whole sector and the Germans run the risk of causing the same mayhem,” said Michael Hewson, an analyst at CMC Markets.

“The ban is even more curious with respect to the shares of the financial institutions involved, given that their share prices have been relatively orderly over the past few days and weeks,” he added.

The ban applies to several banks — Aareal Bank AG, Commerzbank AG, Deutsche Bank AG and Deutsche Postbank AG. It also covers insurer Allianz SE; reinsurers Hannover Re AG and Munich Re AG; Generali Deutschland Holding AG, MLP AG, and Frankfurt stock exchange operator Deutsche Boerse AG.

Investors will now wait to see if others do something similar in the days ahead — a number of analysts think that other eurozone countries, at the very least, will likely follow Germany in banning naked short selling.

In Asia, shares dropped too in the wake of the German decision.

Japan’s benchmark Nikkei 225 stock average dropped 55.80 points, or 0.5 percent, to 10,186.84. South Korea’s Kospi index lost 0.8 percent to 1,630.08 and Australia’s S&P/ASX 200 index was off 1.9 percent at 4,387.10.

Benchmarks in Singapore, India and Indonesia all fell more than 1 percent and Hong Kong’s Hang Seng index lost 1.8 percent to 19,583.22.

Benchmark crude for June delivery was down 11 cents to $69.30 a barrel in electronic trading on the New York Mercantile Exchange. The contract fell 54 cents to settle at $69.41 on Tuesday.

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Associated Press Writer Alex Kennedy in Singapore contributed to this report.